For example, qualified dividends are taxed at an effective rate of zero percent for those individuals who are in the 15% tax bracket. The 2015 tax brackets for a couple that is married and filling jointly is posted below (Source: IRS.com):
| Taxable Income | Tax Rate |
| $0 to $18,450 | 10% |
| $18,451 to $74,900 | $1,845.00 plus 15% of the amount over $18,450 |
| $74,901 to $151,200 | $10,312.50 plus 25% of the amount over $74,900 |
| $151,201 to $230,450 | $29,387.50 plus 28% of the amount over $151,200 |
| $230,451 to $411,500 | $51,577.50 plus 33% of the amount over $230,450 |
| $411,501 to $464,850 | $111,324.00 plus 35% of the amount over $411,500 |
| $464,851 or more | $129,996.50 plus 39.6% of the amount over $464,850 |
This is the 2015 tax bracket for a single individual (Source: IRS.com):
| Taxable Income | Tax Rate |
| $0 to $9,225 | 10% |
| $9,226 to $37,450 | $922.50 plus 15% of the amount over $9,225 |
| $37,451 to $90,750 | $5,156.25 plus 25% of the amount over $37,450 |
| $90,751 to $189,300 | $18,481.25 plus 28% of the amount over $90,750 |
| $189,301 to $411,500 | $46,075.25 plus 33% of the amount over $189,300 |
| $411,501 to $413,200 | $119,401.25 plus 35% of the amount over $411,500 |
| $413,201 or more | $119,996.25 plus 39.6% of the amount over $413,200 |
The personal exemption in 2015 was $4,000 per taxpayer. The standard deduction was $6,300 for a single person or $12,600 for a married couple.
Let’s see what this means that a married couple whose only source of income is qualified dividends. Let’s also assume that this lucky couple earns $95,000 in annual qualified dividend income in 2015.
Since their taxable income is less than $74,900, this couple is in the 15% tax bracket. Under the current legislation, individuals in the 15% tax bracket pay zero taxes on qualified dividend income and long-term capital gains.
| Gross Income | $ 95,000.00 |
| Standard Deduction | $ (12,600.00) |
| Personal Exemption | $ (8,000.00) |
| Taxable Income | $ 74,400.00 |
On a side note, using an average yield of 4%, this couple would need a dividend portfolio which is worth somewhere between $2.30 - $2.40 million. Accumulating such a nest egg could very well take years. If they are smart about their spending however, they likely need much less to live off in retirement. This early retiree for example, the famous Mr Money Mustache, lives on less than $25,000/year, which at 4% yield translates into a nest egg worth approximately $625,000. In my case, the annual spending is between $18,000 - $24,000 per year.
If we are talking about a single individual, the maximum amount of qualified annual dividend income that they can earn is “only” $47,750. At an average yield of 4%, this retiree can afford to retire early with a cool $1.2 million.
| Gross Income | $ 47,751.00 |
| Standard Deduction | $ (6,300.00) |
| Personal Exemption | $ (4,000.00) |
| Taxable Income | $ 37,451.00 |
The most shocking thing is that if you also have Roth IRA income, under current legislation none of it would be taxable. So if your Roth IRA generated another $50,000 - $100,000 in annual dividend income, none of that would be taxable either. But you already know that. Perhaps this is one of the reasons why I am maxing out my tax-deferred accounts today, with the intent to slowly converting those dollars into Roth after leaving the rat race, and pay zero taxes in the conversion. The dividend income from my taxable accounts will be tax-free even if it is ridiculously high at $50,000 - $70,000/year. This is much more than I need.
As I mentioned in the beginning of the post, our tax system is set up in a way to provide preferential treatment to providers of capital. Early retirees are indirectly benefiting from this provision, because they are living off their capital.
Relevant Articles:
- Dividends Provide a Tax-Efficient Form of Income
- Taxable versus Tax-Deferred Accounts for Dividend Investors
- How to save over $60,000/year in a Roth IRA
- Roth IRA’s for Dividend Investors
- Health Savings Account (HSA) for Dividend Investors
DGI,
ReplyDeleteSuppose you made $110,000 in dividends. Would the first $74,900 still be tax free, and the balance taxed at the 15% rate?
For a married couple, with no other income - first ~$95K in qualified dividend income will be tax free on federal level
DeleteThe next ~$15K in qualified dividend income will be taxable at 15%.
I assume that if you have other taxable income (e.g., required minimum distributions)that exceed 95K, all dividends would be taxed at 15%?
DeleteIt all depends on the situation. I think that if you have $95K in qual dividends and $20K IRA distribution, only a portion is taxable at 15%.
DeleteA useful tool is taxcaster: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
DGI,
ReplyDeleteEvery time I look at the tax brackets here in the states I cringe. This is exactly why I've put so much focus into my portfolio rather than waiting around for my earnings to reach the next bracket. It's inevitable that the long you know what of the tax man will come to get us. It's best to protect what we have before he comes and ruins all of our fun income. Hopefully the wife and I will be able to retire right before hitting the next bracket to avoid the next big hump of taxes that come with it.
-Dividend Reaper
This is why it is important to diversify assets. I hold shares in taxable accounts, but also in tax-deferred accounts such as 401K or Roth or HSA.
DeleteIf the single person has qualified dividends over $37,450 does he only pay taxes on the dollars that he goes over by? I.E. tax free dividends under this amount and pay on what you go over or does going into the 25% tax bracket nullify all of the tax savings and now all of your qualified dividends are taxed at %15.
ReplyDeleteThanks for the article.
As I mentioned in the article, for a single person, qualified dividend income has to exceed $47,750 for dividends to be taxable ( assuming no other income).
DeleteDue to marginal tax rates, I believe only the amount above 47.75K would be taxable at 15%. But I may be wrong. Ask your CPA/tax preparer for info.
Otherwise, you may want to play around with this tool:
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
Hello, I´m Jorge I´m from Spain. I want to Know how you do in your blog, because I´d like to learn more about dividend. I´m sorry for my English. It´s so bad. hehe I have a blog but I only have share of Spain.
ReplyDeleteI've done 2 returns this week with couples over $100,000 Adjusted Gross Income that paid no tax because it was all/mostly qualified dividends or long term capital gains (same tax treatment) with itemized deductions that get them to the 15% bracket or below. What a country...
ReplyDelete